Fraud - Weighing up the true cost

Most senior executives believe their business controls are robust enough to prevent all but the most tenacious of fraudsters making off with a substantial sum of money.

Sadly though, this confidence may be unjustified. A survey of finance directors, conducted recently by Neville Russell, showed that nearly seven out of ten companies had experienced a material loss from fraud during the last five years. And while just as many expressed confidence in the ability of their internal controls to prevent fraud in the future, almost half believed they were at a greater risk from fraud than five years ago.

There is clearly a reality gap. In fact, it could be argued that the attitude of many FDs does more to encourage dishonesty than to tackle financial loss through deception. This situation has arisen over the inherent tension in a system that balances the cost to the business of the right controls against income those controls are designed to protect.

Supermarket chains, for example, now offer self-service shopping to certain premium-rated customers. As they go around the store, a hand-held device is used to key in the price of the goods put into the baskets. The total is then debited from the customers’ accounts.

With such a system, a dishonest customer can easily pay #40 for goods worth #60, by keying in sardines, for example, and walking away with caviar.

But the supermarket’s main controls comprise the initial credit check on the customers offered the service and a spot check on a percentage of outgoing customers. The supermarket is prepared to accept some shrinkage from fraud, provided that it does not outweigh the additional income and customer convenience.

In general, the more innovative IT becomes, the more there is a drive towards a very naked assessment of the cost of fraud to a company weighed against the cost of the controls needed to prevent it.

This perception can cloud the fact that the oldest problems of dishonesty are merely transformed into modern processes. Today’s forger, for example, is someone who can covertly access an IT system and then proceed to authorise transactions as though it is the genuine manager processing them.

Consequently, FDs have got to be able to recognise new methods of deception and act promptly by putting the right controls in place. Despite the complicated nature of modern finance, the mark of a good control is still that it can be readily performed and easily checked.

Having sound control systems does not necessarily translate, though, into a good track record in investigating and dealing with the perpetrators of fraud, something that partly arises from the attitudes of those entrusted with such investigations.

The survey indicates that, where the authorities had carried out investigations, 14% of respondents said they were disappointed by the lack of results and only 11% of prosecutions had resulted in a conviction. Perhaps as a result of this poor performance, only one in five of those questioned said they would report an incidence of suspected fraud to the police, while a mere 23% said they had used the authorities to investigate frauds when they had been victims.

Protecting corporate image

Behind that statistic lies one particularly confusing factor. Boards of directors zealously protect their companies’ reputations, but often in negative ways. The disclosure in open court that they have suffered loss by fraud is inherently perceived as detrimental to the corporate image.

In contrast, Prudential Assurance declared last year that all instances of employee wrongdoing would be unfailingly reported to the authorities.

Few companies have yet followed that lead, even though Prudential policyholders presumably hear this as a comforting message about the security of their funds.

But it is not all down to the FDs and senior management. There are broader public policy issues at work here too.

The police also suffer from a lack of resources. In the Home Office’s assessment of crime-prevention priorities, fraud lies very low on the list of offences competing for government funding.

When resources are allocated to a force’s HQ, cash for fraud is trifling compared with that given to cover crimes such as burglary, rape, assault or theft, even though losses through fraud dwarf those from burglary.

In civil trials, a privately instructed fraud investigator does not always achieve the objectives set by his client. Some resort to unauthorised rummaging in the dustbins of the target, or paying employees to breach their employment contracts by divulging confidential information, or even breaching bank secrecy. Only later do the company’s lawyers discover that the evidence is inadmissible.

Once at court, serious fraud trial juries are sometimes said to have difficulties in understanding the evidence. Few jurors possess commercial or financial acumen, but they may be subjected to several days’ worth of complex evidence.

During a period at the Serious Fraud Office, I was involved in the investigation and prosecution of five contested BCCI jury trials. Each resulted in a conviction. The period for response to the Home Office’s consultation document ‘Juries in Serious Fraud Trials’ has just ended.

I would not like to predict what its outcome will be, but it is good to see the issues being addressed.

Preventing and detecting fraud should be at the top of every business’ agenda. It is not enough to treat it as an unavoidable overhead to be kept within a set budget. Producing the right culture of zero tolerance in the workplace will help us in the difficult task of identifying and appropriately punishing fraudsters.

If a fraud does take place, seeking accounting advice and support from the professionals who understand forensic integrity and are used to working with lawyers, will always be advisable.

Peter Hyatt is a forensic & investigation services partner at Group A firm Neville Russell.